The Good, the Bad and the Lucky: CEO Pay and Skill

CEO compensation varies widely, even within industries. In this paper, we investigate whether differences in skill explain these differences in CEO pay. Using the idea that skilled CEOs should be more likely to continue prior good performance and more likely to reverse prior poor performance, we develop a new methodology to detect whether skill is related to pay. We find that highly paid CEOs are more skilled than their less well paid peers when pay is performancebased and when there is a large shareholder. This detected link between pay and skill is strong even when we examine industry-wide declines: highly paid CEOs are more likely to reverse the firm’s fortunes. We also examine CEO turnovers and show that the firm’s post-turnover performance is related to differences between the two CEO’s pay levels. These results highlight conditions where pay and skill are linked, and hence identify firms where high pay appears to have no justification

Takeovers, Governance and The Cross-Section of Returns

This paper considers the impact of the takeover channel on firm valuation. We use the idea that takeover activity responds to investor expectations of future rate of return and hence to state variable(s) related to the time variation in risk premia. Thus firms with higher exposure to takeovers, due to higher expectations of receiving a takeover premium, have a higher exposure to the state variable that dictates time variation in risk premia. Consequently, the difference in the returns between firms that differ in their takeover vulnerabilities can be used to used to proxy these state variables. To do so, we create a takeover-spread portfolio that buys firms with low cash-adjusted-leverage (cheaper targets) and shorts firms with high cash-adjusted-leverage and show that such a portfolio generates annualized abnormal returns of up to 11.20% between 1980 and 2003. Also, abnormal returns associated with governance-spread portfolios (Gompers, Ishii and Metrick, 2003 and Cremers and Nair, 2004) decrease significantly once the asset pricing model includes this ’cash-adjusted-leverage’ factor. Finally, we propose a new ‘takeover’ factor to proxy for the risk due to changes in these risk-premia related state variables, which is shown to be important in explaining cross-sectional differences in equity returns. The paper shows why investors require a higher rate of return on firms exposed to takeovers and yet value them higher than firms protected from takeovers

The Impact of Shareholder Control on Bondholders

This paper investigates the effect of shareholder control on bondholder wealth. While stronger shareholder control can benefit bondholders by disciplining managers, it also increases the likelihood of events that can hurt bondholders, e.g. hostile takeovers. We hypothesize that shareholder control can have contrasting effects on bond yields depending on the takeover vulnerability of a firm. Using the presence of an institutional blockholder to proxy for shareholder control and firm-level anti-takeover provisions to proxy for takeover vulnerability, we find that shareholder control is associated with lower yields if the firm is protected from takeovers. We also find that shareholder control is associated with higher yields if the firm is exposed to takeovers. The contrasting effects of shareholder control on yields are the strongest for firms that are small and have low leverage. In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 93 basis points. Further, the results are insignificant for a sub-sample of firms where the bondholders are protected from takeovers through the poison put covenant. Bond ratings also appear to incorporate a similar effect of shareholder control on bondholders Finally, we find that a bond pricing model that does not account for shareholder control generates an annualized abnormal return of 1% to 1.4% for portfolios that long firms with both strong shareholder control and high takeover vulnerability and short firms without either shareholder control or takeover vulnerability. Combined, these results suggest that the use of different governance mechanisms, such as shareholder monitoring and takeover vulnerability, depends on a firm’s capital structure and that bond-pricing models should account for shareholder control

The Role of Banks in Takeovers

To transfer loans from one debtor to another debtor, banks might transmit borrower information which is collected in the lending process to potential acquirers. In this paper, we investigate the importance of banks in the effectiveness of the takeover mechanism and hence in corporate governance. Using unsolicited takeovers between 1992 and 2003, we find that bank lending intensity and bank client network (the number of firms that the bank deals with) have a significant and positive effect on the probability of a borrower firm becoming a target. We find that this effect is enhanced in cases where the target and acquirer have a relationship with the same bank and is robust to the inclusion of several firm characteristics including the presence of large external shareholders. Moreover, takeover completion rates are positively related to bank lending intensity. Finally, we find that the equity market views takeovers where the target and the acquirer deal with the same bank more positively relative to takeovers with no bank involvement. Overall, the evidence supports the view that banks increase the disciplining role of the market for corporate control

The Good, the Bad and the Lucky: CEO Pay and Skill

CEO compensation varies widely, even within industries. In this paper, we investigate whether differences in skill explain these differences in CEO pay. Using the idea that skilled CEOs should be more likely to continue prior good performance and more likely to reverse prior poor performance, we develop a new methodology to detect whether skill is related to pay. We find that highly paid CEOs are more skilled than their less well paid peers when pay is performancebased and when there is a large shareholder. This detected link between pay and skill is strong even when we examine industry-wide declines: highly paid CEOs are more likely to reverse the firm’s fortunes. We also examine CEO turnovers and show that the firm’s post-turnover performance is related to differences between the two CEO’s pay levels. These results highlight conditions where pay and skill are linked, and hence identify firms where high pay appears to have no justification

The Impact of Shareholder Control on Bondholders

This paper investigates the effect of shareholder control on bondholder wealth. While stronger shareholder control can benefit bondholders by disciplining managers, it also increases the likelihood of events that can hurt bondholders, e.g. hostile takeovers. We hypothesize that shareholder control can have contrasting effects on bond yields depending on the takeover vulnerability of a firm. Using the presence of an institutional blockholder to proxy for shareholder control and firm-level anti-takeover provisions to proxy for takeover vulnerability, we find that shareholder control is associated with lower yields if the firm is protected from takeovers. We also find that shareholder control is associated with higher yields if the firm is exposed to takeovers. The contrasting effects of shareholder control on yields are the strongest for firms that are small and have low leverage. In the presence of shareholder control, the difference in bond yields due to differences in takeover vulnerability can be as high as 93 basis points. Further, the results are insignificant for a sub-sample of firms where the bondholders are protected from takeovers through the poison put covenant. Bond ratings also appear to incorporate a similar effect of shareholder control on bondholders Finally, we find that a bond pricing model that does not account for shareholder control generates an annualized abnormal return of 1% to 1.4% for portfolios that long firms with both strong shareholder control and high takeover vulnerability and short firms without either shareholder control or takeover vulnerability. Combined, these results suggest that the use of different governance mechanisms, such as shareholder monitoring and takeover vulnerability, depends on a firm’s capital structure and that bond-pricing models should account for shareholder control

Takeovers, Governance and The Cross-Section of Returns

This paper considers the impact of the takeover channel on firm valuation. We use the idea that takeover activity responds to investor expectations of future rate of return and hence to state variable(s) related to the time variation in risk premia. Thus firms with higher exposure to takeovers, due to higher expectations of receiving a takeover premium, have a higher exposure to the state variable that dictates time variation in risk premia. Consequently, the difference in the returns between firms that differ in their takeover vulnerabilities can be used to used to proxy these state variables. To do so, we create a takeover-spread portfolio that buys firms with low cash-adjusted-leverage (cheaper targets) and shorts firms with high cash-adjusted-leverage and show that such a portfolio generates annualized abnormal returns of up to 11.20% between 1980 and 2003. Also, abnormal returns associated with governance-spread portfolios (Gompers, Ishii and Metrick, 2003 and Cremers and Nair, 2004) decrease significantly once the asset pricing model includes this ’cash-adjusted-leverage’ factor. Finally, we propose a new ‘takeover’ factor to proxy for the risk due to changes in these risk-premia related state variables, which is shown to be important in explaining cross-sectional differences in equity returns. The paper shows why investors require a higher rate of return on firms exposed to takeovers and yet value them higher than firms protected from takeovers

The Role of Banks in Takeovers

To transfer loans from one debtor to another debtor, banks might transmit borrower information which is collected in the lending process to potential acquirers. In this paper, we investigate the importance of banks in the effectiveness of the takeover mechanism and hence in corporate governance. Using unsolicited takeovers between 1992 and 2003, we find that bank lending intensity and bank client network (the number of firms that the bank deals with) have a significant and positive effect on the probability of a borrower firm becoming a target. We find that this effect is enhanced in cases where the target and acquirer have a relationship with the same bank and is robust to the inclusion of several firm characteristics including the presence of large external shareholders. Moreover, takeover completion rates are positively related to bank lending intensity. Finally, we find that the equity market views takeovers where the target and the acquirer deal with the same bank more positively relative to takeovers with no bank involvement. Overall, the evidence supports the view that banks increase the disciplining role of the market for corporate control

Oxamniquine resistance alleles are widespread in Old World Schistosoma mansoni and predate drug deployment

Do mutations required for adaptation occur de novo, or are they segregating within populations as standing genetic variation? This question is key to understanding adaptive change in nature, and has important practical consequences for the evolution of drug resistance. We provide evidence that alleles conferring resistance to oxamniquine (OXA), an antischistosomal drug, are widespread in natural parasite populations under minimal drug pressure and predate OXA deployment. OXA has been used since the 1970s to treat Schistosoma mansoni infections in the New World where S. mansoni established during the slave trade. Recessive loss-of-function mutations within a parasite sulfotransferase (SmSULT-OR) underlie resistance, and several verified resistance mutations, including a deletion (p.E142del), have been identified in the New World. Here we investigate sequence variation in SmSULT-OR in S. mansoni from the Old World, where OXA has seen minimal usage. We sequenced exomes of 204 S. mansoni parasites from West Africa, East Africa and the Middle East, and scored variants in SmSULT-OR and flanking regions. We identified 39 non-synonymous SNPs, 4 deletions, 1 duplication and 1 premature stop codon in the SmSULT-OR coding sequence, including one confirmed resistance deletion (p.E142del). We expressed recombinant proteins and used an in vitro OXA activation assay to functionally validate the OXA-resistance phenotype for four predicted OXA-resistance mutations. Three aspects of the data are of particular interest: (i) segregating OXA-resistance alleles are widespread in Old World populations (4.29–14.91% frequency), despite minimal OXA usage, (ii) two OXA-resistance mutations (p.W120R, p.N171IfsX28) are particularly common (>5%) in East African and Middle-Eastern populations, (iii) the p.E142del allele has identical flanking SNPs in both West Africa and Puerto Rico, suggesting that parasites bearing this allele colonized the New World during the slave trade and therefore predate OXA deployment. We conclude that standing variation for OXA resistance is widespread in S. mansoni